Emerging markets offer strong investment opportunities
During the last decade much investor focus has turned to emerging markets. The 2000’s saw the S&P 500 in the United States remain relatively unchanged over a 10 year period. This lack of growth in domestic equity markets has caused many investors to be drawn to the staggering possibilities of growth in emerging market economies such as Brazil, Romani, and South Africa. During times of heightened global risk appetite there tends to be a massive amount of capital flow into these emerging markets as investors seek increased yield. One country that has stood out as an investor favorite over the last decade has been South Africa.
South Africa is definitely an emerging economy and not yet considered a fully industrialized economic power; thus, there are definite risks to investment in the South African Rand, which is why the Rand tends to move in lockstep with the global economy. As a rule of thumb, when the global economy is doing well, the Rand will outperform, and as the global economy weakens, the Rand will also tend to weaken. This is due to the speculative flow of investment capital. Let’s take a look at the South African Rand versus the U.S. Dollar since 2008.
You can see that during the early stages of the 2008 Crisis the U.S. Dollar made a huge and drastic move against the Rand as investors pulled capital from risky assets, such as the Rand, and placed it in the safety of U.S. Dollar-denominated government debt investments and AAA corporate bonds. This mad rush to safety finally peaked out at the beginning of 2009, and as the recovery began to bring economic growth back to the world economy, investors once again began betting on the Rand due to its higher yield, and you can see the rapid strength of the Rand during 2009. In 2010, the Dollar Rand has moved sideways in currency trading as investors are unsure about the global recovery.
Economic drivers of the South African Rand
The high yield associated with the Rand is what has caused it to be a favorite among currency traders when risk appetite is in the market. The South African Rand is currently offering an interest rate of 6.5%. Conversely, the United States is currently offering an interest rate of .25%. If you were an investor, would you rather have your money earning 6.5% or .25%? This is what drives the Rand up versus the Dollar during times of global economic growth.
The fear is that during times of economic uncertainty there is always the small, but very real, chance that the South African government could default on some of its debt. Due to this possibility, during times of economic turmoil, investors will pull their capital out of the Rand.
South Africa is a country with very rich mineral deposits. Therefore, its economy is heavily dependent on commodity prices, specifically gold. South African has incredible amounts of gold reserves, but the lack of economic infrastructure has weighed on South Africa’s gold output in recent years. For example, a few years ago the country experienced extended blackouts as the national electrical power provider ran into serious supply problems. This caused a major shortage of gold exports during that time, and these types of scenarios can weigh heavily on a fragile, emerging market economy. As the price of gold has risen dramatically in recent years, and is currently close to its all-time highs, this has helped to spur economic growth in South Africa, and it has helped bring further strength to the Rand. When foreign nations want to purchase South Africa’s gold, they, of course, have to convert into the Rand to make those purchases and as this capital flows into South Africa, its currency will appreciate.
China is a major purchaser of goods and services in South Africa, and therefore South Africa tends to be heavily influenced by economic developments in China. During the global recession of the last two years, the Chinese economy has performed exceptionally well. In fact, many economists agree that continued economic growth and demand in China over the last two years is what has helped stave off a Great Depression. However, the bustling growth in China is finally beginning to calm down. China began removing economic stimulus from the economy over the past several months, and the effect is finally being felt. Although no one is expecting a severe slow-down in China, the decrease of demand for South African goods from China will be felt negatively in the South African economy. This could cause a further decrease in the value of the Rand over the near term as well, as investor sentiment will begin to dampen marginally.